MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMIC HOCHIMINH CITY j LUC THAO PHUONG HA FINANCIAL DERIVATIVES INSTRUMENT TO HEDGE EXCHANGE RATE RISK IN VIETINBANK BRVT BRANCH In Banking and Finacial Ology code: 60.31.12 MASTER’S THESIS Supervisor : Dr.TRAN HUY HOANG Ho Chi Minh City – 2010 Financial Derivatives 0 DECLARATION I assure that this thesis is my research. This thesis has not already been submitted for any degree and is not being currently submitted for any other degree. The extracts and data from the other studies have been cited clearly. I bear full responsibilities for whatever un-honest of this thesis. Luc Thao Phuong Ha August, 2010 i Financial Derivatives 1 ACKNOWLEDGMENTS It is a good opportunity to participate to the master’s course of Banking in English, which is conducted by the University of Economic Hochiminh City, Faculty of Banking Course. I have achieved a lot of knowledge, methodology, techniques and new ideas from this course. This thesis is a part of my accumulative knowledge that I have gathered from the teachers, classmates and the colleagues. First of all, I would like to express my grateful and indebtedness to my supervisor, Associate Professor Ph.D Tran Huy Hoang who provided me the precious methodology. He helped me a lot in construction of the thesis structure, and gave me the new ideas in analysis. This thesis could not be done without his contribution. I also would like to extend my sincere thanks to all the teachers, who have improved my knowledge of development economics and other social economics understanding. I am grateful for the help from the board of director of Vietinbank Baria Vungtau branch, Mr Tu Nhu Phong, Mr Nguyen Huu Son, Ms Thu Ha, and all my colleagues, who have facilitated me in this research. I highly appreciate the helps from Mr Kien Quoc, Mr Manh Ha, Mr Thanh Hai and all classmates of class of Banking, course 16, who have made a good condition for my study. I would like to give my thanks to all of them. Finally, I express my love to all members of my family, who have encouraged me in the progress of my studying and completing this thesis. Luc Thao Phuong Ha. ii Financial Derivatives Abstract Based on the theory of foreign exchange (forex) market and foreign exchange risk management, this thesis focuses on the involved banking products used to manage risks in trading forex operation. They are financial derivatives. Financial derivatives are rare in Vietnam although they are widely used in international market. An overview of Vietnam forex market from 2007 to now demonstrated to give the reasons why it is necessary to manage foreign exchange risk and what can be done to mitigate risks? Finally, suggestions for applying financial derivative instruments in Vietnam Bank for Industry and Trade (Vietinbank), Baria Vungtau Branch as a new banking transaction are discussed to enhance its position in local province. iii Financial Derivatives TABLE OF CONTENT Page INTRODUCTION 1 1. The rational of the study 1 2. Statement of the research problem 2 3. Research questions and objective 3 3.1 Research questions 3 3.2 Research objectives 3 4. Research methodology 4 5. Signification of the study 4 6. Structure of the study 5 CHAPTER ONE: FINANCIAL DERIVATIVES IN FOREIGN EXCHANGE TRADING IN COMMERCIAL BANKS 1.1 Foreign exchange trading in commercial banks 6 1.1.1 What is a commercial bank? 6 1.1.2 Banking transactions – foreign exchange trading 7 1.1.3 Risks in foreign exchange trading 8 1.1.4 The necessity of managing foreign exchange risk 14 1.2 Financial derivatives in foreign exchange trading in commercial banks 14 1.2.1 What are financial derivatives? 14 1.2.2 Types of financial derivatives in exchange trading 15 1.2.3 Functions of financial derivatives 19 1.3 Conditions to apply and develop financial derivatives of foreign currency 22 1.3.1 Commercial banks’ internal conditions 22 1.3.2 Commercial banks’ external conditions 23 Conclusion 24 iv Financial Derivatives CHAPTER TWO: RESEARCH METHODOLOGY 2.1 Introduction 25 2.2 Research design 26 2.3 Data collection 27 2.3.1 Sample 27 2.3.2 Data collection 27 2.3.3 Hypothesis 31 2.3.4 Scope of the research and data analysis 33 2.4 Conclusion 34 CHAPTER THREE: CURRENT SITUATION IN FOREIGN EXCHANGE TRADING IN VIETINBANK BARIA VUNGTAU BRANCH 3.1 Background of Vietnam’s forex market 35 3.1.1 Characteristics of Vietnam’s forex market 35 3.1.2 Forex trading in BRVT province and Vietinbank BRVT branch 39 3.2 Analysis results 41 3.2.1 Unexpected movement of foreign currency impact on businesses’ activites 42 3.2.2 Business’ demand for using derivatives 47 3.3 Vietinbank Baria Vungtau branch and perceptions about application of derivatives 51 3.3.1 Forward and option contract 52 3.3.2 Combining financial derivatives with credit policy 53 3.3.3 Reasons why derivatives are not popular used in BRVT province 54 Conclusion 57 v Financial Derivatives CHAPTER FOUR : CONCLUSION AND RECOMMENDATION 4.1 Conditions for developing foreign exchange derivatives 59 4.2 Recommendation 62 4.3 Limitation of study and suggestion for further ones 64 4.4 Conclusion 65 LIST OF REFERENCES 66 APPENDIXES 68 ABBREVIATION AUD: Australian dollars BRVT: Baria Vungtau CBI : Central Bank Intervantion CPI: Customer purchase Index EUR: Europe dollar Forex market = FX: Foreign exchange market GBP: Greatain Bristish Pound GDP: Gross domestic product IMF: International Monetary Fund JPY: Japnanese yen OTC: Over the Counter SBV: The state bank of Vietnam SOCB: The state-owned commercial banks USD: United States dollar VND: Vietnam dong Vietinbank: Vietnam Bank for Industry and Trade WB: World Bank WTO: World Trade Oragnization vi Financial Derivatives vii LIST OF CHART Chart 1.1: AUD/USD rate’s movement 10 years 9 Chart 2.1: Outline of Research methodology 25 Chart 2.2: Outline of Hypothesis and variables 32 Chart 3.1: Density inward of foreign currencies 35 Chart 3.2: The movement of VND/USD period 1999 – 2009 37 Chart 3.3: Import – Export turover in BRVT province 39 Chart 3.4: Volume of USD trading in Vietinbank BRVT branch 40 Chart 3.5: USD transferred to Vietinbank from exporters, remittance and demand for USD from importers 51 Chart 3.6: Derivatives trading in Vietinbank BRVT branch and Other banks in BRVT province 52 LIST OF TABLE Table 3.1: Summary of the kind of investigated companies 41 Table 3.2: Descriotive statistic about impact of forex on companies’ activities 43 Table 3.3: Correlation and coefficient of Q7, Q8, Q9 and Q18 44 Table 3.4: Correlation and coefficient of Q10, Q11, Q12, Q13, Q14 and Q18 45 Table 3.5: Correlation and coefficient of Q15, Q16, Q17 and Q18 46 Table 3.6: Frequency analysis of Q19, Q21, Q22 47 Table 3.7: Frequency analysis of Q23, Q24, Q25, Q26, Q27 48 Table 3.8: Frequency analysis of Q28, Q29 and Q29B 50 Financial derivatives INTRODUCTION 1. The rationale of the study In the recent years, the foreign exchange market in Vietnam has been formed and developed. This is actually necessary for Vietnam in the process of integrating into the international economy. Vietnamese businesses as well as commercial banks have recently improved their operating abilities to run the business in the global field. The operation of the foreign exchange market plays an important role in promoting the international foreign trade and economic cooperation among countries. Foreign exchange transaction not only has been now considered as one of important banking services of commercial banks, but also marked a new step forward of banking – modernizing movement. Transactions conducted in the foreign exchange market determine the rate at which currencies are exchanged. The major transactions in foreign exchange market are spot, forward, swap, future contract and currency option. The basic of those transactions is the exchange rate. Exchange rate affects the relative price of domestic and foreign goods, hence exchange rate volatility strongly affects the foreign trade activities between countries. The year 2008 was coming with the pessimistic image of the global economy. It started with the American sub-prime crisis, the international fluctuating price of oil – up and down rapidly, the high inflation and the global economic slowdown… therefore, the forex market around the world has been operating on unexpected movement. Since the event that Vietnam became the official member of WTO, we are directly impacted by these turmoil tendencies, influencing deeply in our country’s emerging economy. The more Vietnam integrates into global economy, the riskier in currency exchange rate the businesses have to exposure. In order to support local import-export enterprises, commercial banks have to develop many kinds of derivatives in foreign currency transaction for hedging exchange rate risk. Vietnam commercial banking system has recently increased its’ abilities to meet the international banking standards. As one of members of Vietnam banking system, 1 Financial derivatives 2. Statement of the research problem Foreign exchange risk management is crucial for businesses frequently trading in the international market. There are many kinds of financial instruments used to risk management, in which financial derivatives have been most popularly used in hedging. Financial derivatives include four main types: forward, future, swap and option. They have been widely used for hundreds of years in international market such as stock market, commodity market, foreign exchange market … Speculators use them to implement their arbitrage transactions to gain profit in financial market. However, the most important effect of financial derivatives is hedging risks – fluctuant changing in prices of goods. In the foreign exchange market, this effect is more important to prevent investors from the rate’s volatility. Firstly, this thesis analyzes risks derived from forex market, and the importance of forex risks management. Then it aims to explain why derivatives have not implied widely in Vietnam yet, and how to encourage this kind of financial instruments as new banking services in Vietnam banks – especially in Vietinbank BariaVungtau branch. The current Vietnamese foreign exchange market will be generally demonstrated, giving its changes affected by outside factors and its influences on local import-export businesses. Then some conditions for development of derivative instruments for hedging foreign exchange rate in Vietnam are analyzed in detail, 2 [...]... exchange risk will be evaluated by questionnaire sent to enterprises in BRVT province in order to find out what can be done to mitigate the foreign currency risk; whether it is necessary to apply the financial derivatives instrument for hedging risk and how Vietinbank BRVT can do to introduce new financial banking instruments to their customers 5 Signification of the study The goal of this thesis is to develop... about risks faced in international trading in terms of currency – the large and rapid fluctuant movement in exchange rate in Vietnam To study the demand of import – export enterprises in BariaVungtau province whether foreign exchange hedging risk is important? 3 Financial derivatives To launch some kinds of financial derivatives in term of foreign exchange to meet market’s demand as well as increase Vietinbank. .. who happen to dislike risk (risk averse) to those who will take it for a profit They are considered as risk- management financial tools, however, if not managed correctly they can be risky Financial derivatives are so effective in reducing risk because they enable financial institutions to hedge risks – involving engaging in a financial transaction that offsets a long position by taking an additional short... repo rate 19 Financial derivatives Hedging Hedging is a financial strategy designed to minimize one's exposure by providing end users the opportunity to reduce or transfer exposure to various types of risks Hedging requires taking an offsetting position, so that an exposed position is protected from rising/ falling interest rates or changing exchange rates in one direction of the other While hedging... use option involving contingent transactions to be executed when and if the actual contingencies arise 3 Ghassem A Homaifar, Managing global Financial and Foreign – Exchange rate Risk, Page 100 22 Financial derivatives 1.3.1 Commercial banks’ internal conditions Commercial bank’s potential Financial derivatives are the effective instruments to hedge risk for all involved parties If an investor uses bank’s... course forex trade can not avoid risks Many types of risks are analyzed involving to businesses as well as banks’ activities, then this chapter introduces the main effective financial instruments used to hedge risks is derivatives Derivatives are the financial instruments which play a useful and important role in hedging and risk management in commerce and finance for thousands of years This chapter also... their risk by re-selling this forward to other party, or combining some transactions to minimize the risk Financial derivatives market is complicated and diversified, it requires bank staff has to be equipped knowledge of forex and their financial derivatives The staff is responsible for introducing products, consulting, convincing bank’s customers of taking derivatives functions in their business... as banking services as well as applying financial derivatives instruments 5 Financial derivatives CHAPTER ONE: FINANCIAL DERIVATIVES IN FOREIGN EXCHANGE TRADING IN COMMERCIAL BANKS 1.1 Foreign exchange trading in commercial banks 1.1.1 What is a commercial bank? Banks are financial institutions that accept deposits and make loans Included under term banks are firms such as commercial banks, savings and... and what financial derivatives – products and services - do Vietinbank can provide to its customers? 4 Finally, in addition to consolidate Vietinbank BariaVungtau Branch s position with its competitors and protect itself from foreign exchange risk, this thesis concentrates on how to use financial derivatives instruments as a managerial method William Zikmund (1997) classified research methods into four... in the interest rate or currency swaps The interest rate index used may not be perfectly correlated with the floating rate interest rate in the swap For example, the LIBOR index used in floating rate notes may go up by 0.8 percent, while the cost of borrowing by a financial institution pegged to an index of money market funds increases by 1 percent over the same period The swap cash flow for the financial . currency risk; whether it is necessary to apply the financial derivatives instrument for hedging risk and how Vietinbank BRVT can do to introduce new financial banking instruments to their customers There are many kinds of financial instruments used to risk management, in which financial derivatives have been most popularly used in hedging. Financial derivatives include four main types: forward,. MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMIC HOCHIMINH CITY j LUC THAO PHUONG HA FINANCIAL DERIVATIVES INSTRUMENT TO HEDGE EXCHANGE RATE RISK IN VIETINBANK BRVT